When the Fair Work Commission announced a 3 per cent increase in the national minimum wage to more than $640 a week - or almost $16.90 an hour - from last week, employers hinted it would lead to fewer people getting jobs and maybe some people losing theirs.
And to many who've
studied economics - even many professional economists - that seems
likely. If the government is pushing the minimum wage above the level
that would be set by the market - the "market-clearing wage" - then
employers will be less willing to employ people at that rate.
because market forces set the market rate at an unskilled worker's
"marginal product" - the value to the employer of the worker's labour.
common sense, really. Except that such a conclusion is based on a host
of assumptions, many of which rarely hold in the real world. And over
the past 20 years, academic economists have done many empirical studies
showing that's not how minimum wages work in practice. They've also
developed more sophisticated theories that better fit the empirical
facts. It's all explained in the June issue of the ACTU's Economic
As a result, there's been a big swing in academic
thinking on the question of the minimum wage. Last year, researchers at
the University of Chicago asked a panel of economists from top US
universities whether they agreed with the statement that "the
distortionary costs of raising the federal minimum wage to $US9 per hour
and indexing it to inflation are sufficiently small compared with the
benefits to low-skilled workers who can find employment that this would
be a desirable policy".
Fully 62 per cent agreed and 16 per cent
disagreed, leaving 22 per cent uncertain.
Earlier this year, more
than 600 US economists - including seven Nobel laureates - signed an
open letter to Congress advocating a $US10.10 minimum wage. They said
that, because of important developments in the academic literature, "the
weight of evidence now [shows] that increases in the minimum wage have
had little or no negative effect on the employment of minimum-wage
The first such study, published by David Card and Alan
Krueger in 1994, compared fast food employment in New Jersey and
Pennsylvania after one state raised its minimum wage and the other
didn't. They did not find a significant effect on employment.
then, many similar US "natural experiments" have been studied and have
reached similar findings. In Britain, the Low Pay Commission has
commissioned more than 130 pieces of research, with the great majority
finding that minimum wages boost workers' pay but don't harm employment.
been less research in Australia, but one study by economists at the
Australian National University, Alison Booth and Pamela Katic, suggests
that the facts in Australia seem to fit the "dynamic monopsony" model of
Under the simple textbook, "perfect competition"
model of the market for labour, individual firms face a horizontal
supply curve: each firm is so small that its demand for labour has no
effect on the price of labour. It can buy as much labour as it needs at
an unchanged price.
In the dynamic monopsony model, however, each
firm faces an upward-sloping labour supply curve. This is because more
realistic assumptions recognise the existence of "imperfections" or,
more specifically, "frictions".
Such as? Workers may not have
perfect information about all the alternative jobs they could take and
this could make them cautious about moving. Searching for a job may
involve costs in time or money. Workers and jobs may be mismatched
geographically, so changing jobs may involve greater transport costs.
Workers - being humans rather than inanimate commodities - may not have
identical preferences about the jobs available.
In other words, there are practical reasons why it takes a lot for a worker to want to leave their job.
frictions, or "transaction costs", are assumed away in the simple
model. But their existence can result in employers having market power,
which they can take advantage of to pay workers less than the value of
what they produce (their marginal product).
Economists call such
power "monopsony" power. Just as a monopolist is a single seller, so a
monopsonist is a single buyer. But don't take that word too literally.
An employer with monopsony power doesn't need to be a monopolist in the
market for its product (the "product" market), nor the sole buyer of
labour in the region or the industry.
"A single employer in a
market with many employers can have monopsonistic power if workers bear
costs of job search," the article continues. In other words, it
possesses a degree of monopsony power.
The point is, if a firm is
facing an upward-sloping labour supply curve and wants to hire more
workers, it may need to pay a higher wage than it is paying its existing
workers. So, if it goes ahead with hiring, it will need to increase the
wage rates of its existing workers.
And this means the firm's
profit-maximising level of employment and wages will both be lower than
they would be under perfect competition.
In such a model, if the
minimum wage rate is set at or below the marginal product of labour,
this won't cause employment to fall and may cause it to rise.
Monopsonistic models don't have an unambiguous prediction for the
employment effect of a minimum wage.
A paper by Bhaskar, Manning
and To, published in the Journal of Economic Perspectives in 2002,
concluded that "a minimum wage set moderately above the market wage may
have a positive effect or a negative effect on employment, but the size
of this effect will generally be small".
It will be interesting to
see how long it takes those many Australian economists who don't
specialise in studying the labour market to catch up with this change in
their profession's thinking.